Why Direct-To-Customer Succeeds or Fails

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The term Direct-to-Consumer (DTC) refers to companies that make products and sell them to consumers, usually online but some in their own branded stores, avoiding traditional multi-brand retailers like department stores. One example is Warby Parker (I just bought glasses from them) but there are many others. The concept is simple: sell the product to the consumer at a price above traditional wholesale but lower than retail. Use the premium over the wholesale price for marketing to replace what retailers traditionally performed (along with their store rent and promotion costs). The consumer pays less but the producer makes the same profit and builds a direct relationship with their consumer.

Two Key Numbers 

It doesn’t always work out that way. To succeed in DTC, two numbers have to line up in the right place. The first is gross margin (GPM).  GPM is what’s left over when you subtract the variable cost of what you’re selling from the price. Successful DTC companies have a gross margin of at least 50% and it can get as high as 85% depending on the product. Many companies got into DTC businesses telling investors that as they scale, their gross margin will rise. In reality, you can improve gross margin incrementally as you grow but never enough to make a bad business good. If the gross margin is wrong, nothing much else matters, improving gross margin by 10 percentage points or more is almost never realistic. 

The second number is CAC, or customer acquisition cost. DTC brands have to attract consumers to their website, store or app and CAC is the cost of that. CAC was such things as advertising on Facebook, Instagram and other social media but now those companies know how much value they’re adding and have adjusted their costs accordingly. DTC companies that rely primarily on social media advertising are often now unprofitable. 

Sometimes entrepreneurs  believe they’ll get economies of scale in CAC as they grow. That almost never happens and the opposite is often true. The first customers are the most receptive and therefore the least expensive to reach. To convince other customers takes more impressions and that means more CAC. CAC is often erratic and can vary widely month-to-month.

Managing two numbers sounds so simple but when you hear of a DTC company failing, it’s almost always because of gross margin or CAC. If one those numbers are wrong, the business won’t make it. 

How Successful DTC Companies Do It

Successful DTC companies have a number of strategies to minimize their CAC. But you can’t copy another company’s CAC strategy. What makes customer acquisition most effective is that companies have their own unique voice, their own unique channel, their own unique strategy for reaching customers. Consumers will sense that a copied strategy is fake and it may fail, it needs to be custom-fitted to each particular company. Here are what some companies are doing:

  • A DTC newborn clothing company called Monica and Andy presents itself as an event-driven business. That event is the birth of a child, usually a couple’s first. Monica and Andy offers education about pregnancy and parenting, both online and in its three stores and makes consumers feel more like members than customers and that leads to buying products. That feeling creates repeat customers and Monica and Andy sells products up to size 8.
  • Similarly, a young company selling inexpensive suits online for wedding groomsmen called, The Groomsman Suit, likewise presents itself as event-driven, focusing on the weddings of friends. Remarkably, this focus has enabled the company to maintain its sales and profitability even during the precipitous decline of weddings and other social events during the pandemic shutdown. 

Both companies rely on getting their customers to tell their friends about their event experiences, and that often includes their experiences buying products. Word-of-mouth has always been the most effective advertising, and the cheapest, but it’s the hardest to get. By ingraining themselves into the important event and leveraging it to reach new customers, both companies keep their customer acquisition costs at attractive levels.

Athleta, which sells yoga-related apparel in its own stores, runs yoga studios inside all its stores and online and consumers don’t have to buy product to go to their classes. The concept is the same as every theme park you’ve ever been to: you can’t get in or out without passing through the store and inevitably, product sells. Importantly, the experience consumers have in the yoga studio solidifies their identity with the brand. 

Some DTC companies have used the most counterintuitive strategy possible: they sell wholesale. The idea is to use third-party retailers to expose consumers to the brand and drive customers to the brands’ websites. I used this strategy many times. DTC companies with a wholesale strategy are extremely selective; they choose only a few wholesale customers and only allow their product to be sold in certain stores of that customer. 

Some DTC brands open their own stores. On the surface, that seems like the reverse of what direct-to-consumer should be. But stores now have a different purpose. Of course selling product is part of that purpose but another part is brand awareness and to help consumers find their website or app…think Apple.

There’s a temptation among DTC brands to focus entirely on new customers and assume the rest takes care of itself once they buy. But customers don’t always come back without encouragement and targeting existing customers has lower CAC and higher effectiveness and value. This “leaky boat syndrome” is when new customers leak out because they’re not being marketed to appropriately. 

Like other companies, DTC companies also expand the dollars they get from existing customers when they grow horizontally with new products. But choosing the right kind of product to expand with is challenging. A DTC company called Made In sells high end cookware, like pots and pans, at direct-to-consumer prices. Wanting to expand, they needed to choose a product with an association to cookware that could benefit from their credibility. They focused on plates, something consumers could easily see was within their expertise and that would help grow the average order value. 

There are also marketplaces to help brands find marketing partners, like Wove and Dojomojo, that help DTC marketers find complementary brands they can share costs or run promotions with. Examples of collaborations are: 

  • Wine retailer Winc including inserts from fashion discounter RueLaLa and luxury bedding company Byourbed in its delivery boxes. 
  • Bicycle brand Jenson USA sending inserts to the customers of shaving brand Harry’s.
  • Apparel brand Everlane partnering with The New York Times to generate attention about climate change and create interest in both their brands.

Of course, influencer/third-party-endorsor marketing allows brands to have a unique voice but convincing that influencers are authentic is a major concern. A great example is a beauty company called AshleyBlackGuru where the founder herself is the influencer, the most authentic kind of influencer marketing. Ashley Black herself has said, “founders have to speak for themselves…they can’t hire out social media and affiliates…How can someone else be you online?”

We are clearly not done seeing the creative ways that brands can use to reach their customers. Especially as new technologies develop, brands will find new ways to market while holding costs down. Brands that keep on using established methods will watch their costs rise until the effort is no longer economic. Adapting to change rapidly, especially in customer acquisition, is one of the factors that makes DTC brands successful but one thing will not change: gross margin and customer acquisition costs have to be right or the whole effort will fail.

For more information about DTC, view the free video entitled Marketing For Business Owners Session 1.

Copyright ©John Trenary 2021

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